Jacob: It seems that the statute was intended to help workers but it actually hurts them.

Rachel: Many feel-good statutes, like minimum wage laws, have that effect. In the 1970’s, the University of California at Santa Cruz abolished letter grades and instructed its faculty to give evaluations of students. Many students believed that evaluations would give a better picture of the student’s strengths and weaknesses than a letter grade.

But when students applied to professional schools (law schools, medical schools, business schools), they had evaluations, not grade point averages. The admissions committee often found it difficult to judge the academic performance of these students. Evaluations hurt many students who might have been accepted to professional schools if they had grade point averages. It is hard to estimate the effect, but many students applying to law schools and medical schools asked to have letter grades.

The problem is, the workers don't end up getting the $10 because of the new law.  The firm simply cuts down to 25 workers, and pays all of them $6 (firms over 25 employees are the only ones that have to pay the higher wage).

So, now there are 25 workers making $6/hour (Total of $150/hour), whereas before, there were 30 making $6/hour (Total of $180/hour).  If I was a worker, I'd much rather have 100% chance of making $6 than a 5/6 chance of making $6.

It might be a different question if the employer still had to pay the $10 to the remaining 25 workers, but I don't think that's what this HW was getting at...

[NEAS: The firm pays $6 to the remaining 25 workers.  The effect of a minimum wage law is to raise unemployment.  That is the upshot of the textbook, and this story (an actual municipal case in 2004) shows the expected effects.]

Microeconomics, Module 21, “The Market for Labor” (Chapter 16)

Homework Assignment

(The attached PDF file has better formatting.)

Some towns and cities have passed statutes requiring higher wages. This homework assignment examines the economic results of these statutes.

We do not judge the morality of these statutes or whether low paid workers are exploited by firms. Exploit is a normative term, implying that firms unfairly appropriate the wealth of their workers. Landsburg does not deal with normative issues and does not use this term.

Scenario #1: A firm with 30 workers now pays them $6.00 an hour. From each worker, the firm gains $11.00 an hour, so its net profit is $5.00 an hour. A new statute sets a minimum wage of $10.00 an hour for firms with 30 or more employees. The advocates of the new statute say the firm will now pay $10.00 an hour, so its net profit is $1.00 an hour and its workers receive a better wage.

We examine three cases:

α: The firm pays $6.00 an hour to thirty workers.
β: The firm pays $10.00 an hour to thirty workers.
γ: The firm lays off 5 workers and pay $6.00 an hour to 25 workers.

For each case, work out the

●    Total revenue of the firm.
●    Total labor costs of the firm.
●    Net profit of the firm.

For case α, the total revenue is $11 × 30 = $330 an hour; the total labor costs are $6 × 30 = $180; and the net profit is $330 – $180 = $150. For the homework assignment, determine the corresponding figures for cases β and γ and answer the items below.

A.    Total revenue when it pays $6.00 an hour to 30 workers? (30 × $11.00)
B.    Total labor cost when it pays $6.00 an hour to 30 workers? (30 × $6.00)
C.    Total profit when it pays $6.00 an hour to 30 workers? (30 × $5.00)
D.    Total labor cost if it pays $10.00 an hour to 30 workers? (30 × $10.00)
E.    Total profit if it pays $10.00 an hour to 30 workers? (30 × $1.00)
F.    Total revenue if it lays off 5 workers and pays $6.00 to 25 workers? (25 × $11.00)
G.    Total labor cost if it lays off 5 workers and pays $6.00 to 25 workers? (25 × $6.00)
H.    Total profit if it lays off 5 workers and pays $6.00 to 25 workers? (25 × $5.00)
I.    What is the expected response of a profit maximizing firm to the new labor law?
J.    What is the expected change to unemployment?
K.    Do workers gain from the new law?
L.    Do firms gain from the new law?

Some argue that the new laws are aimed at large firms that employ many workers and earn large profits from each worker. Consider the scenario below, which reflects the more typical case.

Scenario #2: A firm with 100 workers now pays them $6.00 an hour. From each worker, the firm gains $16.00 an hour, so its net profit is $10.00 an hour. A new statute sets a minimum wage of $10.00 an hour for firms with 30 or more employees. The advocates of the new statute say the firm will now pay $10.00 an hour, so its net profit is $6.00 an hour and its workers receive a better wage.

If we examine the cases outlined above, the firm earns greater profits by retaining its workers and paying them $10.00 an hour than by laying off 75 workers and paying the rest of the workers $6.00 an hour.

To examine this scenario, we assume the firm would pay $6.00 an hour if it moved its operations to a neighboring town (Town ZZ), but the move would cost $250,000. Assume the revenue of the firm does not change if it moves to ZZ.

A.    What is the difference in labor costs if the firm moves to ZZ? {($10.00 – $6.00) × 100 workers each hour.}
B.    What is the difference in net profit?
C.    Assuming the work week is 40 hours, what is the difference in weekly profits?
D.    How many weeks would it take the firm to recoup the moving costs?
E.    What is the effect of the new statute on unemployment?

We infer nothing about fairness or equity. Landsburg implies the following:

●    In competitive markets, firms produce at minimum cost and earn just the required return on capital; they earn zero economic profits. Only monopolies and other firms with market power earn economic profits (in the long-run). To ensure optimal social welfare for consumers, keep the markets competitive; don’t try to legislate prices or quantities.
●    In competitive markets, labor earns a wage that reflects its marginal product. If the wage is low, the marginal product is low. This may occur because many persons are seeking work in a given industry. Mandating a higher wage rate, even if it is successful, puts people out of work, reduces the quantity produced, and raises prices.

In this example, if the market is competitive, the $16.00 an hour revenue may provide a fair return for owners of fixed land, suppliers of capital, and managers of the firm. If it is excessive, another firm will enter the market and sell the product at a lower cost. But we can’t raise social welfare by mandating higher wages.